The factors that determine the level of commercial bank lending rates are important concerns to policy makers, the banking industry and the public at large. From a policy perspective, lower lending rates are desirable, as they tend to have a positive influence on new and existing investments, improve the competitiveness of Jamaican businesses and contribute to growth and development. These welfare effects would lead to generally higher living standards and financial surpluses. On the other hand, well known studies of developed country markets have shown that profits in the banking industry tend to rise as interest rates increase. The rapid expansion in the local industry since 1990 would also lend itself to the perception that such a relationship would also hold in the Jamaican context. There is little wonder therefore that the interest rates charged by local banks have been a sensitive and recurring policy issue in Jamaica and one which requires an objective examination of all the factors behind the structure of commercial bank interest rates.

Loan rates can be separated into two major components – the interest rate paid to depositors and the rate added on by banks. That difference between the deposit rate and the loan rate is commonly referred to as the spread. The size of banking spreads serves as an indicator of efficiency in the financial sector because it reflects the costs of intermediation that banks incur (including normal profits). Some of these costs and are imposed by the macroeconomic, regulatory and institutional environment in which banks operate while others are attributable to the internal characteristics of the banks themselves. The objectives of this paper are to establish the time path of banking spreads in Jamaica and the main factors influencing their evolution.